Currency crises: can high reserves offset vulnerable fundamentals?

Jie Li () and Alice Y. Ouyang ()

Applied Economics, 2011, vol. 43, issue 16, pages 2055-2069

Abstract: First generation crisis models suggest that the size of international reserves affects only the timing of a crisis while second generation models imply that higher reserves can reduce the probability of a crisis. First in the literature, this article suggests the 'rolling probit model' to successfully demonstrate that high reserves can be effective in offsetting vulnerable fundamentals in a vulnerable zone. The more vulnerable fundamentals in the vulnerable zone require higher levels of international reserves to reduce the probability of a crisis. If the fundamentals are sufficiently bad, the level of needed reserves may be explosive, which makes a crisis unavoidable. Unlike the arbitrary proposals of reserve adequacy measures in current literature, this article also sheds light on such measures based on the relationship between vulnerable fundamentals and high reserves.

Date: 2011
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